Counterfeit Parts in DoD s Supply Chain: Presentation to ABA PCLS Small Business Committee on Section 818 of 2012 NDAA January 23, 2013

Transcription

1 Counterfeit Parts in DoD s Supply Chain: Presentation to ABA PCLS Small Business Committee on Section 818 of 2012 NDAA January 23, 2013 Jeffery M. Chiow 750 Ninth Street, N.W., Ste 710 Washington, D.C jchiow@rjo.com

2 The Challenge of Counterfeit Electronic Parts to the DoD Supply Chain

3 What is the problem? Components and systems entering the DoD supply chain contain counterfeit parts that make it impossible to predict when or how the systems may fail. The failure or threat of failure due to counterfeit parts reduces reliability of weapons and systems. Reliance on potentially compromised systems risks loss of life and property and may cause mission failure. The incentives for counterfeiters and the often faceless global nature of the supply chain for electronic parts makes fixing the problem difficult. Supply chain integrity is necessary, but expensive.

4 Shenzen China SMT Corp. Photos from SASC

5 Shenzen China SMT Corp. Photos from SASC (cont.)

6 SASC Investigative Report (May 2012) Eight key findings: China is the dominant source country for counterfeit electronic parts; The Chinese government has failed to take steps to stop counterfeiting operations; DoD lacks knowledge of the scope and impact of counterfeit parts on critical defense systems; Permitting contractors to recover costs incurred as a result of their own failure to detect counterfeit electronic parts does not encourage the adoption of aggressive counterfeit avoidance and detection programs; The use of counterfeit parts in defense systems can compromise performance and reliability, risk national security, and endanger the safety of military personnel; Industry s reliance on unvetted independent distributors to supply electronic parts for critical military applications results in unacceptable risks; Weaknesses in the testing regime for electronic parts creates vulnerabilities; and The defense industry routinely failed to report cases of suspect counterfeit parts, putting the integrity of the defense supply chain at risk.

7 Recent History of Efforts to Assess and Respond to Counterfeit Electronic Parts

8 Counterfeit Parts Awareness Timeline 2008 INSIDE THE AIR FORCE BUSINESS WEEK DoJ Prosecutions PRO IP Act 2009 NASA comments to HEC DoJ Prosecutions 2010 Dept. of Commerce, BIS Study IPEC Working Group Formed Boeing/L-3 Comm./Raytheon GAO Report: DoD Leverage DoJ Prosecutions 2011 Dept. of Commerce, Telecom DoD MIBP S2T2 Review SASC Investigation & Hearing 2012 NDAA 2012 GAO Report: Internet Fakes AT&L Overarching Memo SASC Investigation Report Deadlines for DoD Action June 28, 2012 September 26, 2012

9 Which small businesses will be affected? Depends on nature of small business and its customers Impact is present if a supplier of electronic parts, components, assemblies, systems Or provide maintenance for same. Such small businesses will be affected by 818 rules

10 How will the Rules reach them? They are not covered contractors under the law Rather, because they are in the supply chain to covered contractors The law requires covered contractors to flow down obligations Apart from flow-down, customers who are covered contractors will bear the financial consequences (unallowable costs) and other adverse effects should a small business furnish what is suspected to be or is a counterfeit part.

11 How will contracts be affected? The natural tendency of the covered contractors, especially at the highest tier, will be to push down requirements and to shift liability to suppliers for consequences they may experience. Hence, a small business very likely will see terms and conditions that, for example, ask for certification that parts are not counterfeit, or that demand that the small supplier indemnify the customer.

12 Practically, what does this mean? As a financial matter, such small firms cannot accept these terms The general disposition of small suppliers will be to limit their liability to NMT purchase order price No sensible small business will take on a contractual risk to enterprise liability for a part that it may acquire (or sell) for just a few dollars. Even if a small business were to certify or indemnify, the higher tier contractors would not find the resources of the typical small business sufficient to realize any genuine protection

13 What should a small business certify or guarantee? As a technical matter, small firms cannot (or at least should not) accept such demand The nature of counterfeits makes it essentially impossible to certify or guarantee authenticity An irreducible risk exists, if small, even when buying from OEMs and OCMs, that a part may be suspected of being counterfeit, or be counterfeit under a potentially applicable definition The most that a prudent firm can do is to document what it does to assure authenticity and to reduce the risk that a part is counterfeit E.g., the company can describe the tests that it has performed and certify that these have been done And it can certify that it acts in compliance with standards

14 Some requirements will be easier to meet Verification and refresh of records retention, standards certification compliance and Records retention & traceability That it has performed testing, either as a standard practice, or as specially may be required by the customer. In other words, the key is to work with the customer to define, in the P.O., what risk abatement measures (whether institutional, or item-specific) will be taken, and to perform those measures as required, and be able to deliver documentation to establish they were performed.

15 Continued demand for small business purchases Why? Because of small business participation goals, setaside And because some needed parts, for new production or maintenance, will not be available from OEMs, OCMs or authorized distributors And because some purchasers, knowing the above, would prefer to have a small business take the risk of buying from other than such a trusted supplier

16 What can small firms do? Refusal to participate in the defense market (not likely) Limit their parts purchases, where possible, to OCMs, OEMs and authorized distributors ( trusted suppliers ) Establish and validate a small number of other sources (than trusted suppliers), e.g., distributors or brokers, whose records of authenticity warrant confidence Where using such other sources, inform customer and/or seek customer direction and assent Join and/or follow compliance bodies such as ERAI, TRACE Establish relationships with independent test and verification resources, such as to facilitate rapid access to greater levels of testing as may be required for particular parts

17 What can small firms do? (continued) Document internal process and procedure to govern supply chain in order to reduce risk of purchase/sale of counterfeits, e.g., preference for trusted suppliers, narrow list of approved other suppliers, hierarchy of test methods, retention of documentation Examine all business functions that touch on the supply chain to assure practices consistent with good counterfeit parts avoidance practices, e.g., Appropriate disclosure and documentation of potential and known risks

18 Opportunities that 818 presents? By building in counterfeit risk prevention By compliance with existing and emerging standards By participation and/or monitoring of gov t and industry developments (818 tells covered companies that they should purchase from trusted suppliers but a huge gap is left where the needed parts cannot be obtained from these sources. This is a gap that small business can help fill by becoming trusted sources. This role may be performed by acquiring parts from independent distributors or reliable brokers, or by taking on roles for device re-manufacture or through contract manufacture or assembly redesign.

19 Semiconductor Industry Association Picture from SASC

20 Plan ahead! Even before the new rules come out, small businesses will see flow down of terms and requirements that they must be very careful to examine and resist. Small businesses may need to seek assistance in the evaluation and negotiation and in development of practice and process improvements.

21 ATTORNEY CONTACT Jeffery M. Chiow Associate

22 About RJO -- GOVERNMENT CONTRACTS San Francisco (1981) Washington, DC (2011) Chambers USA GovCon Tier 2 (top 9 nationally) 14 GovCon Attorneys Experience across the spectrum Impressive clients Thought leadership Cleared attorneys, SCI capable